The new long-term private capital

(January 2008) With recent stock turmoil pushing BCE shares to well below the takeover price negotiated by a consortium led by the Ontario Teachers’ Pension Plan, speculation has been that Teachers’ will walk away from the deal. But Teachers’ incoming chief, Jim Leech, says simply, “I look forward to the time when Bell is out of the media.”

That’s because he thinks private equity is seeing a new type of investor — pension plans that can invest more cheaply in private businesses than other firms can, and can do so without any pressure to seek an exit and sell the business.

He made those remarks in a speech at a private equity symposium sponsored by the Financial Executives of Canada, the Toronto CFA Society, the Canadian Venture Capital Association and the Canadian Institute of Chartered Business Valuators.

Leech puts the evolution of private equity in the context of the funding needs of OTPP. As a mature plan, Teachers’ has fewer current employees supporting more retirees than ever before. The ratio is now 1.4 active teachers to retirees. In 1970, it was 4 active teachers to retirees. As Leech notes, plain vanilla bonds won’t provide an inflation-adjusted pension for plan members, particularly long-lived ones. The average teacher retires at 57 and receives a pension for 31 years. Survivor pensions last, on average, another five years.

Changing demographics prompted OTPP to become an active investment manager in 1990. Leech points out that OTPP pioneered the use of derivatives and swaps, index strategies, and hedge funds and real estate for pension plans.

It also moved into private equity, but with a twist. “Because of that 70-year timeline — from the start of a teacher’s career to the end of their survivor payments — our private capital has the luxury of being able to hold its investments for the long term.”

That is, if the investments work out. Leech acknowledges that one of the first private investments Teachers’ undertook, in White Rose Crafts and Nursery Sales, was a complete bomb. But Teachers’ directors and executives “knew that, while a certain degree of failure could be expected — that a few dry holes came with the territory — overall there was value to be realized.”

He also cautions that private equity represents less than 20% of Teachers’ $106 billion in capital. Moreover, he argues, Teachers’ is well-diversified, with a risk budget directly linked to liabilities.

The entry of Teachers’ into private equity, he suggests, democratizes investing by providing competition to traditional buyout firms in two respects: time and cost. Teachers’, he says, has no artificial exit deadline. Its investments are long-term buys, such as Maple Leaf Sports and Entertainment, Yellow Pages Group, and now BCE. That isn’t to say Teachers’ won’t sell. It turned around Doane Pet Food in less than a year to “a pet food company that needed it badly enough to pay us a very significant premium that we simply could not afford to refuse.”

Cost is a consideration too. Teachers’ can manage its private equity portfolio for 50 basis points, as against the 2% management fee and 20% incentive fee private firms charge, which nets out to 6%.

That said, however, Leech is anxious to show that “private capital is not the big bad wolf it’s made out to be.” Instead, he cites studies showing that private equity leads to job creation through three processes: improving performance, refocusing the business and buying and building up to improve a company’s competitive position.

Acknowledging that the pace of buyouts has slowed considerably since the credit tide began to ebb in the summer, Leech adds, “we could use a bit of a holiday from the frenetic pace of the last couple of years.”

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com

(01/25/08)